American insurance

Aetna explodes

INSURERS are in the business of assessing risk. But few have been able to grasp the risks of getting into managed care. Ask Aetna, America's largest health insurer. On March 12th, the company said that it would sell some overseas units and split the rest of its operations into two, separating financial services from health care and pensions. The move is a rejection of an offer of $10 billion for the firm made a few days earlier by WellPoint Health Networks, a managed-care company, and ING, a Dutch bank.

Since its heyday in the early 1990s, the managed-care industry has fallen on hard times. Profit margins have fallen by almost half since 1994; investors, who once flocked to the sector, are now giving it a wide berth. Other managed-care firms have also fallen foul of investors. But with 22m customers, Aetna's woes are striking.

Five years ago, Aetna was a big, distinguished insurer, but it was worried about shrinking margins and a falling market share. So it decided to turn itself into a health-maintenance organisation (HMO), a type of business that now dominates the country's private health-care industry.

Its aim was to trade a relatively stodgy business of understanding and pricing risk for one that helped to reduce it. In effect, this meant improving on an insurance company's actuaries guesses at what people might spend on health care by superimposing the medical professionals and protocols that could control it. HMOs have captured most of the corporate-benefits market by promising to keep in check the health-insurance premiums paid by America's large firms, which were once escalating rapidly.

Aetna and others kept to this promise for a time, clamping down on medical procedures and tests doled out by free-wheeling doctors and hospitals. But an increasingly heavy drugs bill, rising consumer expectations and doctors' resistance have combined to start sending medical costs up again by 6-8% a year. In an effort to reassure investors about their profitability, managed-care firms have been raising their premiums; the average increase for 2000 is expected to be at least 10%. Yet Aetna failed to assuage investors' fears. Its share price has fallen sharply in recent months. Since investors would have preferred a takeover, Aetna's latest proposals brought little relief: investors have again dumped the firm's shares.

Although Aetna is not alone in its travails, it has a number of unique problems. It paid $11 billion for three HMOs in recent years. The first of these, US Healthcare, was bought at an extravagant premium; the most recent, Prudential HealthCare, brought its own set of financial troubles to the union. Mergers between managed-care firms are especially tough, because their information systems, and the policies they offer, are very different. Managing three of them in as many years is asking for trouble.

Aetna is also very exposed to the difficulties of Medicare, America's federal health-insurance scheme for the elderly. Roughly a quarter of its $18.5 billion annual health-care revenues come from this market. Since Medicare is financed by the federal government, which is keen to cut costs, HMOs have been unable to raise premiums in this area by more than 2-3% a year, even though the elderly are the costliest people of all to look after. Many analysts think that Aetna should pull out of the Medicare market altogether, as many of its peers did last year.

It would also benefit from better management skills. Aetna is famously heavy-handed with physicians, tying them up in restrictive contracts, and has been cited recently in a number of class-action suits by patients. Its previous chief executive, Richard Huber, made harsh comments about weeping widows and ambulance-chasing lawyers. The new head, William Donaldson, a former chairman of the New York Stock Exchange, will need to tread more deftly.

Without big changes, Aetna's new health-care company is unlikely to prosper. Because of antitrust concerns, few, apart from healthy WellPoint, are likely to bid for it. America's health-care industry now swallows up some 14% of GDP, but it is not an easy business to thrive in.